The Australian reporting season is now underway and the overall mood remains relatively cautious.
Although it's premature to offer a definitive assessment of the reporting season thus far, we have spotlighted several critical earnings reports. These selected reports grant us valuable insights into the stocks within our Focus Portfolio and the market more broadly.
CBA – Australian Households Stay Resilient But Margins Still Falling
CBA’s home loan portfolio remains resilient, but we continue to watch the book closely. Currently, CBA is still seeing only a small number of customers currently falling behind on their repayments.
Both CBA’s 30- and 90-day arrears remain near historic lows. However, CBA has seen some uptick in 30-day arrears in the past 12 months, and management expects 30-day and 90-day arrears will trend higher over the course of FY24.
Bad debts are likely to increase throughout the year, albeit from a low level. The result and management commentary demonstrated that households have considerable repayment buffers, built over COVID, although we are yet to see any substantial impacts from the fixed rate expiry (fixed rate expiries set to peak in 1H24).
Margins still compressing
The result confirmed that CBA’s margins peaked in 1H23. Net interest margins (NIMs) continued to fall with intense competition for home loans and deposits. This competition has cooled somewhat with cash offers for home loans removed and mortgage rates edging higher.
On the other side of the equation, deposits received a lot of attention on the results call with implications for future funding costs and margins. Management called out the intensification of competition in deposits more broadly across the sector but also how the funding mix is shifting towards higher-cost term deposits and savings accounts. These factors will likely remain headwinds for margins over the next 12 months.
Market share falling
The traditional CBA (higher margin brand) lost market share in the 6 months to June 2023. Home lending grew at below system for both 2H23 and FY23, when excluding the lower margin Unloan and BankWest products.
This indicates two things:
- Group volumes are only growing at system due to the low margin Unloan and BankWest.
- Repricing in 2H23 has come at the expense of market share for the higher margin traditional bank. This does not paint a particularly positive outlook on margins.
Banks Downside Risks Reducing
We are getting to the point where a lot of the forward margin compression is now consensus, but there still remains risk in the magnitude of the compression. However, we see less downside risk to margins in FY24 than we did 6 months ago.
In terms of bad debts, the only way is up, but we are getting more clarity from reporting season that households are well positioned for the next 6-12 months. So, while we expect the economy to slow further, bad debts are not expected to be a problem over FY24.
CBA Too Expensive – Result Does Not Change Our View
One of our biggest active positions - with a 7.9% underweight to the stock - the result does not change our position. CBA trades on a ~100% premium to the other big four banks relative to a history of ~55%. Another way to put it is that CBA at 18x trades on a similar PE as the S&P 500, but with no growth. The stock looks crowded.
Headwinds for the bank sector (high competition, shift to higher cost funding) are still prevalent in CBA as they are in the other big four banks.
We cannot justify buying the stock on an excessive premium that is subject to almost identical risks as the other banks. The risk-reward trade-off does not add up.
Our preference is the value side of the sector that does not look expensive, with positions in National Australia Bank (NAB), ANZ (ANZ) and Westpac (WBC).
| Name | Ticker | Price to Book (12 mth fwd) | PE (12 mth fwd) | EPS CAGR Growth (FY23-FY26) | Div Yield (12 mth fwd) | ROE (12 mth fwd) |
| National Australia Bank Ltd | NAB | 1.39 | 12.82 | 1% | 5.9% | 11.4% |
| Westpac Banking Corp | WBC | 1.03 | 11.27 | -2% | 6.5% | 9.5% |
| ANZ Group Holdings Ltd | ANZ | 1.05 | 11.20 | 0% | 6.4% | 9.9% |
| Commonwealth Bank of Australia | CBA | 2.35 | 18.27 | 1% | 4.3% | 12.6% |
Source: Refinitiv, Wilsons.
Premiums Take Flight, Insurers Delight
The recent updates from Suncorp (SUN) and QBE Insurance (QBE) this reporting season have highlighted positive momentum in the domestic general insurance sector, providing a favourable readthrough for our top pick – Insurance Australia Group (IAG) (Focus Portfolio 3%).
Repricing trends have continued to gather momentum with SUN and QBE’s Australian arm both reporting gross written premium (GWP) growth of ~13% vs the previous corresponding period (pcp) for the six months to 30 June 2023. In the case of SUN, IAG’s closest peer, premium rate increases combined with improving investment yields have underpinned a +200bps lift in underlying insurance margins to vs the pcp to 10.9% in FY23, albeit this was partly offset by higher peril allowances and reinsurance costs.
Both SUN and QBE have guided to ~10% of GWP growth in FY24 and CY23 respectively, which is reflective of a rational industry backdrop that should continue to be supportive of improving insurance margins over the medium-term as repricing flows through to offset higher input costs (all going to plan).
All in all these results are a positive readthrough that reaffirms our positive view of IAG and provides a degree of comfort heading into its FY23 result, scheduled on 21 August 2023.
When IAG reports we will be looking for:
- Positive GWP and investment yield trends
- Further colour on the outlook for reinsurance costs
- Confirmation that ‘very high’ client retention rates have been maintained
- Further evidence of input cost disinflation
- Potential BI provision releases supporting capital management
We think there is upside to consensus into the result for IAG and it is still at a reasonable valuation at 16x. IAG traded on an average PE of 18x in 2018-2019.
Not Losing Sleep over ResMed’s Recent Sell-off
ResMed’s (RMD) shares have sold off over the past month on the back of two key concerns.
1
Slower than expected AS11 supply build, but the medium-term story is unchanged
RMD’s FY23 result disappointed investors as the business guided to a slower supply build of its AS11 device than the market had seemingly expected. RMD effectively poured cold water on AS11 supply going ‘unconstrained’ before 2H24, meaning the cheaper/lower margin AS10 product will do the heavy lifting in the near-term. This has translated to ~5% consensus downgrades to FY24 EPS, largely on the back of changes to AS10/AS11 mix assumptions favouring the cheaper AS10 device, which has constrained near-term gross margin expectations.
On the bright side, the FY23 result demonstrated that RMD continues to gain market share from its top competitor Philips, which remains sidelined due to a major product recall. The fact that global flow generator sales are still knocking out 25% growth vs the pcp two years into a major competitor recall provides a strong affirmation of RMD’s market gains to date, which we expect to be durable in nature.
Ultimately, the slight delay to AS11 supply becoming unconstrained (relative to market expectations) means little competitively or strategically, apart from depriving investors of an earnings surprise ‘sugar hit’ that could have boosted stock performance near-term. Most importantly, our medium and long-term view remains intact with RMD still well placed to carve out permanent CPAP market share gains from the Philips recall, while gross margins should improve over time as AS11 supply builds.
2
The threat of weight loss drugs
Market sentiment towards RMD has undoubtedly been rattled by the potential disruptive threats posed by expanded access to existing weight loss drugs (most notably GLP-1 receptor agonistics) and how this could impact the prevalence of sleep apnea in the community and therefore CPAP device demand.
We are relatively sanguine about the risks to RMD given:
- Out-of-pocket costs can be prohibitively high
The list prices of GLP-1 agonists Ozempic, Mounjaro and Wegovy range from US$1-1.5k per month. In the US, payer coverage for weight loss drugs is limited and there is no funding for obesity drugs by US government-sponsored programmes (e.g. Medicare), with a few exceptions. In many instances, patients have to pay out-of-pocket, rendering these drugs unaffordable for many. - Sleep apnea is a deeply underpenetrated market
Diagnosis rates of obstructive sleep apnea in the US are estimated at less than 20% and ~35% for moderate-severe patients. Therefore, there is still a long runway for growth in the CPAP market, and even modest improvements in diagnosis rates could effectively cancel out the potential top-line effects of weight loss drugs on CPAP demand. - RMD is poised to carve out permanent market share gains
RMD continues to operate as a quasi-monopoly player and remains well placed to experience durable market share gains with Philips still sidelined from the CPAP market. RMD’s ability to maintain above-system growth should help insulate the business from any top-line sector headwinds resulting from weight loss drugs.
Our investment thesis remains intact as RMD is still poised to benefit from permanent market share gains over the medium-term, in what is still a significantly underpenetrated market. Investors should take advantage of this pullback, which has created a rare opportunity to buy shares in a world-leading medical device company with a strong earnings outlook at a ‘cheap’ price, with RMD now trading at an FY24 and FY25 PE of just ~26x and ~23x respectively (vs its 5 yr average of ~34x).
James Hardie (JHX) – Margins Cementing
James Hardie reported impressive 1Q24 results, exceeding both consensus expectations and the company's own guidance from FY23. NPAT was at US$174.5m, a 16% beat on consensus expectations and 13% above JHX's guidance.
2Q24 NPAT guidance set at US$170-190m was above consensus by 20% at the midpoint. JHX jumped 15% after the result and we have seen FY24 EPS upgrades of 13% flow through since the result.
North American market volumes are holding better than expected. The company has shown resilience with impressive margins, thanks to both price/mix adjustments, optimised operational spending, and fall in the price of freight.
James Hardie is well positioned even with a backdrop of macro headwinds and is expected to benefit from a cyclical recovery in US housing over the next 12-24 months. The investment focus remains on growth in the fibre cement category, US housing undersupply
since the GFC, and the ageing of US housing stock.
The positive long-term outlook for JHX remains unchanged, and the stock's valuation is seen as compelling relative to growth potential, trading at an FY24 PE of ~20x.
We expect further upgrades to earnings over the next 12 months, so you can buy the stock on a cheap PE that is currently underearning.
Written by
Rob Crookston, Equity Strategist
Rob is an experienced research analyst with a background in both equity strategy and macroeconomics. He has a strong knowledge of equity strategy, asset allocation, and financial and econometric modelling.
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